Interest Rates and the Role of Parliament

The current framework for the conduct of monetary policy in Australia (of which interest rate setting is a key part) is widely regarded as effective and credible. The Reserve Bank of Australia (RBA) influences economic activity and inflation through setting an operational target for a key interest rate, the official cash rate (the interest rate on overnight loans made in the money market). Since 1996, the RBA has pursued the formal objective of keeping consumer price inflation between 2 per cent and 3 per cent, on average, over the economic cycle, and it sets its operational target for the cash rate to meet this objective. The RBA has maintained a good record in controlling inflation in recent years through its targeting approach.

The level of interest rates is of major concern to the 42^nd Parliament because of their impact on individual borrowers and lenders, and on economic activity more generally. Further, while interest rates are independently set by the RBA, its actions are often taken to reflect on the government’s economic management. Twice a year, the Commonwealth Parliament undertakes particularly close scrutiny of interest-rate issues and associated economic policy through the RBA’s appearance before the House of Representatives Standing Committee on Economics, Finance and Public Administration. This is the main mechanism through which the RBA is accountable to the people of Australia.

The transcripts from recent appearances, together with a range of published information that the RBA produces, give an indication of its current medium-term view on inflation. Clearly, the RBA continues to retain a bias towards further tightening of rates. For example, in announcing an increase in the cash rate on 7 November 2007, it stated:

During 2007, the pace of growth of demand and output has also increased. There are few signs of that strength diminishing as yet, and reports of high capacity usage and shortages of suitable labour persist. Growth in labour costs has been contained so far, and high levels of investment are adding to productive capacity in some sectors. The rise in the exchange rate will help to contain pressure on prices. But growth in aggregate demand will, nonetheless, need to moderate if inflation is to be kept to
2–3 per cent in the medium term.

This suggests that, over the medium term at least, a continuation of the tightening cycle that began in 2002 is likely. Issues that may arise over the course of the 42^nd Parliament in this context include:

• the appropriate mix of policy and incentives to encourage investment in key supply side infrastructure
• the likely impact of past and future government spending and/or tax cuts on aggregate demand and inflation, and
• the effects on household balance sheets and housing affordability of any further rises in interest rates.  

From time to time over the course of the 42nd Parliament, other more procedural issues are also likely to arise in regard to the RBA’s conduct of monetary policy. In the recent past, for example, there has been public debate on the transparency of RBA Board appointments, the non-publication of Board minutes, and the RBA’s choice of measures of underlying inflation.

Documentation
Reserve Bank of Australia, Statement on Monetary Policy, November 2007.
Reserve Bank of Australia, Bulletin, various issues.

House of Representatives Standing Committee on Economics, Finance and Public Administration, Official Committee Hansard Transcript, ‘Reference: Reserve Bank of Australia annual report 2006’, 17 August 2007.